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Healthcare Reform and a New Producer Tax

The US Senate recently passed their altered version of the House's healthcare reform bill. Among hundreds of other economically harmful proposals, the Senate bill, HR 3590, will create several onerous new taxes on the producers of health goods and services.

The Tax on Insurers

In Title IX, Section 9010 of the bill, the Senate proposes a new direct tax on health-insurance providers in dense and esoteric language. The annual amount of the new tax for any insurer is defined as the sum that when divided by $6.7 billion yields the same result as

(The firm's net premiums for all US health risks insured + 200% of third-party administration fees received by the firm)

Divided by

(Aggregate premiums received by all private insurers + 200% of all third-party administration fees received by all firms)

Simple mathematical understanding reveals that the structure of this ratio ensures that the tax will fall most heavily on those insurers whose total premiums constitute the largest share of the total market for health insurance. Politically, this tax is an attempt by Congress to award itself a certain measure of backdoor authority over the execution of antitrust law.

Economically, this tax is a draconian attack on the largest health insurers in America. While Austrian analysis advocates against attacks on firms of an arbitrary size or market share in all cases, this conclusion is especially important when considering the market for health insurance.

Insurance companies profit by separating their clients into "risk pools" and charging monthly premiums that reflect the collective financial risks of those pools. If both the timing and the cost of consumers' future health outlays were known by insurers in advance, insurers would enjoy guaranteed profits by selling insurance to each consumer at a price just above his future health outlays.

In reality, however, health insurers must constantly collect new data on maladies and their methods of treatment, hedge against the financial risks of unknown future costs, and account for the possibility of losses due to fraud and errors in calculation, all while optimizing the timing of their cash flows.

With such monumental challenges in mind, it is clear that insurance is a market that favors large firms with diverse clienteles. The addition of new customers, rather than indicating some sort of unfair monopolization or "bloating," is a natural and necessary outcome of the provision of insurance. Increases in size will occur until a firm's management is no longer able to handle additional growth.

Large firm size benefits both clients and insurers, and should not be penalized with a new progressive tax. This tax will result in a smaller-than-efficient typical firm size and therefore smaller-than-efficient risk pools, which will create unnecessary and unwanted financial risks that must be mitigated by higher premiums.

The ratio also includes 200% of all fees received by a firm for managing another insurer's health risks, which is a harsh disincentive for those insurance firms who manage other firms' health benefits packages. By making such contracts much more expensive for the insurance firm, the tax makes any "outsourcing" of benefits management by a large employer much more expensive.

"This tax is an attempt by Congress to award itself a certain measure of backdoor authority over the execution of antitrust law."

As a result, large firms that now provide employee health insurance will either deduct more for their benefits packages or attempt to manage the plan internally. Firms that outsource plan management to insurers, by the very act of doing so, demonstrate that their managers do not believe themselves competent to manage the plans.

Therefore, this tax will lead to poorer management of employer-provided health insurance plans that, by government fiat, can no longer be inexpensively outsourced. For employees, this will mean more expensive premiums and more erratic claims-payment practices, both of which undermine the benefits to employees of having insurance in the first place.

The Tax on Capital Production

Section 9009 of Title IX establishes a new tax, or as the bill calls it, an "annual fee," on all producers and importers of medical devices. This tax is calculated similarly to the tax analyzed above, the tax to each individual producer being defined as that sum which, divided by $2 billion, is equal to the producer's percentage share of the market.

The implications of this tax are similar to those of the tax on insurers; it is an attack on the utilization of economies of scale in the production of medical capital goods. However, the analysis of a tax on producers of medical devices must take into consideration another dimension, namely that of economies of scope. "Economies of scope" refers to the profitability of diversifying rather than specializing.

For example, a firm specializing in artificial hearts may enjoy economies of scope in the production of vascular-care equipment due to the firm's access to dually useful knowledge. The same firm, however, will likely face diseconomies of scope in the production of prosthetic arms, due to the need to maintain an entirely separate stock of capital goods.

Just as with firm size, a firm's optimal scope would be determined by the profit-and-loss mechanism on the market. This tax, then, will discourage expansions of firm scope along the margins.

In more concrete terms, this means that medical-goods companies will be less likely to produce medical devices that have complementary relationships with their main products, or to produce different devices that enable the treatment of similar afflictions. To the health-services consumer, this implies higher risks of device failure and fewer available treatment methods for any given malady.

This tax on the capital supply also implies that hospitals and clinics will face higher costs to replace their capital stocks, which of course are composed almost entirely of medical devices that will be made scarcer by the tax. Thus, institutions will likely continue to use their medical devices beyond the point of degradation at which they would now be deemed unsafe for medical use.

Conclusion

The so-called "Patient Protection and Affordable Care Act" in fact will make access to health insurance more expensive and less useful, and will also render the care provided by insurance less effective, more risky, and more expensive by taxing the production of new capital goods. The taxation approach taken by Senate Democrats is a purely foolish method of funding regulations that are themselves horrible.

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